Knowledge is power (and the lack thereof can be costly), and this is particularly true with risk management. Ensuring adequate insurance of certain risks is an important consideration in any financial plan. There are several types of risk to manage (portfolio, disability, life, etc.), however in light of the natural disasters that have happened and are currently happening, the focus of this blog post is risk related to property and casualty insurance, with a focus on homeowner’s insurance. If you’ve experienced premium reductions in the last few years, beware. A concerning trend in homeowner’s property insurance has emerged – the trend is the appearance of sub-limits for “Ordinance and Law” provisions (a.k.a. building code upgrades).
Insurance policies and premiums are largely based on the amount of risk exposure (i.e. the dollar value of exposure) and the likelihood a covered event will occur. The more exposure to risk, the more expensive the premium. The more risk events are covered, the more expensive the premium. Thus the opposite is also true, the less exposure the insurance company insures, the less expensive the premium. The concerning trend is that insurance companies are adding sub-limits to policies – a sub-limit caps what they are responsible for paying on a claim. The effect of a sub-limit is, that by limiting exposure, it allows insurance company to reduce premiums and therefore create the illusion of a better deal to the homeowner. The problem occurs when one thinks they have more coverage than they actually do. To highlight the issue, here’s an example:
Steve and Sally Sample own a home in Sonoma, California, with a value of $600,000. The estimated cost for a full rebuild is $400,000. Their homeowner's insurance policy had the following provisions:
A Dwelling - $400,000
10% Ordinance/Law - $40,000
B Personal Property - $200,000
C Loss of Use – Actual Loss sustained
The home catches fire causing considerable damage. The cost to rebuild is $400,000 and of that $60,000 is related to building code requirements. In this case, the insurance is only going to pay $380,000 (only $40,000 of the $60,000 building code upgrades) and the Samples are on the hook to come up with the $20,000 out of pocket, on top of their deductible.
This simple (yet powerful) example highlights the recent trend that insurance companies have subtly introduced in policies that reduce their risk exposure by introducing sub-limits. We have reached out to an insurance professional and asked what red flags exist that homeowners can use to identify potential risks in their policies:
- Home Based Business Endorsement: If the insured runs a business out of their home, they must have an endorsement on the policy covering business pursuits, otherwise personal liability is void. Usually this endorsement is free to add to the policy depending on the type of business, the carrier just needs to know about it.
- Ordinance and Law Coverage: Coverage that applies when a home must be updated to current building code. Example: If an insured's home in Sacramento County, built in 2004, is damaged 40% or more in a fire or other covered loss, Sacramento County requires the home be demolished and rebuilt. The coverage A limit ONLY applies to rebuilding the home to the state it was in prior to the loss. Coverage A does not cover the cost of demolition, clean up, or code upgrades. New homes built after 2010 greater than 1,900 square feet require full automatic sprinkler systems. A homeowner could easily be out $75,000 if they don’t carry ordinance and law coverage and most policies only offer 10% of coverage A, not nearly enough.
- Animal Liability: Dog bites are excluded in the standard HO3 form for personal liability. If the insured owns an animal, aggressive or not, they really need to have an animal liability endorsement on the policy. This won't always be on the declarations page, but it will be listed somewhere in the endorsements if they have it.
- Personal Umbrella: As a homeowner this is a must have, but not all are equal. Although personal umbrellas are by far the cheapest and easiest way to increase liability limits, one must ensure that the underlying limits are sufficient (Section 1). Also, personal umbrellas usually do not go over UI/UM limits, you have to go to specialty carriers if you want that coverage.
- Charity/Board Positions/Business Pursuits: Most people don't know that if you serve on a non-profit 503(c) board, youth sports league board, or have celebrity status, the personal liability and umbrella coverage does not apply. This means that if you are the Vice President of a soccer league, and you get sued personally for an action you may or may not be liable for, your personal liability and umbrella would not apply. The league should have D&O coverage to protect you, but most do not for cost reasons. Personal Umbrellas, just like homeowner’s liability, does not provide coverage for business pursuits. If a client owns a business and gets sued for sexual harassment, the only protection they would have is EPLI coverage, personal insurance will not provide coverage.
- Deductibles: Carefully review the perils deductibles. In California, homeowner’s insurance has two types of deductibles, a flat fee deductible, or a Coverage A percentage deductible. Many of the captive carriers (State Farm, AAA, All State, etc.) have switched people from a flat deductible to a percentage deductible to keep the premiums down. The problem is homeowners don't realize that their deductible can easily go from $1,000 to $5,000. In many Midwestern states you need to keep an eye on the split deductible limits for base deductibles vs. wind/hail deductibles.
- Open Perils vs. Named Perils: All homes written on the standard HO3 form will have open perils coverage for the dwelling, but you need to make sure the policy has an endorsement for open perils on the contents. Open perils coverage is a much more comprehensive coverage than named perils.
- Scheduled Items: Most homeowner’s policies only include $5,000 max per item limits for jewelry, antiques, fire arms, furniture, etc. Also, by scheduling the items that are of high value, many times the carrier will waive the deductible in the event of a theft or fire loss. If the claim is filed under mysterious disappearance/lost, a deductible will apply but coverage will exist.
The key point to be taken from this information is that shopping for insurance policies based on price and coverage limits alone is a bad idea. Instead, be sure to understand how a large claim will be handled and how the policy exclusions work. A reputable insurance broker can help provide clarity. It may take a little investment of time to do so but it will be well worth it should an accident happen.
Special thanks to Jeremy Parker of G.L. Anderson Insurance Services, Inc. for contributing the list of red flag item of items 1-8 above.
The information in this blog post is for educational purposes only and should not be viewed as an endorsement or solicitation for sale of any product or service.